George Osborne's fiscal rules are not fit for purpose. Cutting spending and the other measures announced in the Budget are no way to boost growth
Today’s budget will come in for criticism for failing to do enough to support growth in the UK economy, and rightly so. The chancellor’s measures, including cutting current spending to boost capital spending by £3 billion and reducing the corporation tax rate to 20 per cent, will have little effect on growth, particularly in the short-term.
The prime minister and the chancellor have invested all their political capital in the idea of a debt crisis and the necessity for public spending cuts to resolve it. As a result, they cannot contemplate a change of policy to support growth, because to do means they would have to admit they have been wrong for the last three years.
They fear this would result in a sharp fall in their reputation for economic competence and thus in their prospects at the next general election.
What the chancellor should have done is announce an additional £15 billion of public spending on infrastructure in 2013/14 and a further £15 billion in 2014/15, to be funded by extra borrowing. This would have given an immediate boost to demand and growth in the economy and encouraged private sector investment in the future.
Of course, this would have meant adding to public debt. £30 billion is the equivalent of 2 per cent of GDP (though the increase in the debt ratio would be less because growth would be higher).
This would not have created a debt crisis. The Office for Budget Responsibility’s latest forecast projects a peak in the debt ratio at 86 per cent of GDP in 2016/17. This compares with the forecasts it made in June 2010, which showed debt peaking at 70 per cent of GDP in 2013/14. Yet government bond yields in the UK are close to their record low levels.
The chancellor is now expected to miss by two years his target for debt as a percentage of GDP to be falling in 2015/16. He is also expected to first achieve a surplus on the cyclically-adjusted current budget in 2016/17, two years later than envisaged in June 2010. Not only is fiscal policy failing because it is not doing enough to support growth, it is failing under its own terms.
The two are, of course, related. The government’s tax increases and spending cuts have contributed to the weakness of economic growth; weak economic growth has led to reduced tax revenues and higher spending on welfare; and this in turn has necessitated high borrowing and more debt.
The prime minister and the chancellor say you cannot borrow your way out of a debt crisis. But you cannot get out of a growth crisis by cutting spending, particularly when any further easing of monetary policy is likely to be ineffectual. And without growth, the chances of cutting borrowing and bringing the rise in debt under control are slim (as Norman Lamont and Ken Clarke realised in the 1990s).
Governments should borrow more when households and businesses are not prepared to, as now; when there are spare resources in the economy so that private spending will not be crowded out, as now; and when interest rates on public debt are low, as now. Borrowing – and debt – should be cut when the economy is strong and the cost of borrowing is high.
The chancellor’s fiscal rules have proved not fit for purpose. At the time of the next general election, borrowing and debt will both be well above the levels he hoped to achieve by 2015.
Monetary policy is being made more contingent on growth in future; the same should be true for fiscal policy. Debt needs to be reduced substantially when growth has recovered, but until then the government should be taking advantage of low interest rates to borrow more and invest additional resources in infrastructure.
Tony Dolphin is chief economist at the Institute for Public Policy Research
